January 1997 A description of Bosnia's current arrangements in fiscal federalism and the challenges proposed by the Dayton system - as well as general lessons for the design of fiscal federal systems in ethnically diverse economies. The challenge of fiscal federalism in Bosnia is perhaps unique in the world. The Dayton talks held in October 1995, immediately after a cease-fire, assumed a totally blank slate: How would the new nation that emerged as a result of the peace talks be structured, fiscally? How would be the roles of the central state and of the two subnational units (the entities) that constituted it? How would the three previously warring communities of Croats, Bosniacs, and Serbs work together to form a central government, what would the entity governments look like, and what would their fiscal functions and rights be? How would the entities, in turn, be structured internally, and what would be their fiscal governance? These questions were open in October 1995, when the international community worked with experts and political leaders to forge for Bosnia a new constitution and the new fiscal system that would be laid out in it. Fox and Wallich describe Bosnia's current arrangements in fiscal federalism, outline the unique challenges that the Dayton system proposed, and draw lessons for the design of fiscal federal systems in ethnically diverse economies. This paper - a product of Europe and Central Asia, Central Europe Department - is part of a larger effort in the department to analyze fiscal federalism issues in transition economies.